Friday, November 1, 2013

Real Options and Finance Ideas in our Teaching (not only in Business School).

I know that we teach decision analysis in some of our courses in our policy school at USC, and perhaps ideas like Black-Scholes. But in thinking about a lecture in my defense policy course, where uncertainty and consequences are high and costs are constrained, I realized that the general idea of finance and more concretely, real options, would be useful to convey to our students, undergrads and masters, more generally. In an econ course, two weeks could be devoted to finance ideas (namely, volatility and random walks, options, no-arbitrage). And in public policy courses or real estate development, the notions of an option must already be conveyed, at least implicitly. I see that Richard deNeufville and David Geltner of MIT and Yongheng Deng of Singapore recently gave a paper at a real options conference on real estate design and development planning

I have noticed that my colleagues in law may well be economics literate and law-and-econ practitioners, but finance and options are not part of their everyday discourse. When someone gave a paper on options, the finance notion was in the author's mind but not much in the paper or in the audience’s minds.And option for them was some sort of future choice, but not what finance calls options.

I may well be years behind in what we teach. So please excuse this back-seat-driving.-------People have written me that the math and formulas may be too difficult for many students. I am not concerned about that. The basic ideas are straightforward, and you could always make a decision tree with a few branchings. The difference from most decision analysis is that you pay now for the chance to make a choice later, and you don't have to know which choice you will make until then.